Trend Growth

While it might be tempting to think that the economy should grow at a very high rate all the time, the economy has limits to how fast it can grow – in other words, because economic resources are scarce, the economy has a potential growth rate.

Potential output is an estimate of what an economy could feasibly produce when it fully employs its available economic resources. The Congressional Budget Office (CBO) estimates potential output by estimating potential GDP, which it describes as "the economy's maximum sustainable output." Economists sometimes refer the economy’s potential growth rate as trend growth.

Of course, at any given time, there might be a difference between actual output and potential output. Although rare, it's possible for actual output to be higher than potential output – or above trend. It is far more common, though, for actual output to be lower than potential output – or below trend. The difference between actual output and potential output is called the output gap. The short-run fluctuations of actual output around potential output determine the business cycle—a term used to describe the fluctuating levels of economic activity in an economy over a period of time measured from the beginning of one recession to the beginning of the next.

Knowing the economy’s potential growth rate, or trend growth, is important because policymakers consider the output gap when determining whether the economy needs more or less stimulus. For example, when the economy is experiencing a negative output gap, meaning growth is below its trend the Federal Open Market Committee (FOMC) is likely to lower its target range for the federal funds rate to lower interest rates and ease financial conditions for consumers and businesses.

The goal is to keep the economy growing as close to trend as possible.